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If you like the idea of a Roth, then you’re going to love the supersize version, known as a mega backdoor Roth.

If fortune smiles on you, this strategy could allow you to stash an extra $37,500 into a Roth IRA or Roth 401(k) in 2020. But that “if” is big. You could even call it mega.

First, some background and a caveat

With a Roth IRA, you put in money after paying income tax on it, and then those dollars grow tax-free. But income rules restrict who can contribute to a Roth, and there’s a maximum IRA contribution limit each year. (It’s $6,000 in 2020; $7,000 if you’re 50 or older.) A traditional IRA gives you an immediate tax break on your contribution, your money grows tax-deferred and you pay income tax when you pull out your money in retirement.

A backdoor Roth is a strategy for people whose income is too high to be eligible for regular Roth IRA contributions. You simply roll money from a traditional IRA to a Roth. There are no income or contribution limits — that is, anyone can convert any amount of money from a traditional to a Roth IRA. But you risk a hefty tax bill on the rollover if you have pretax money — either contributions you’ve deducted or investment earnings — sitting in any traditional IRAs, thanks to the IRS’ pro-rata rule. Read more about that rule in our backdoor Roth IRA guide.

A mega backdoor Roth takes it to the next level, as we describe below. It’s for people who have a 401(k) plan at work. The caveat: Creating a mega backdoor Roth is complicated, with many moving parts and the potential to get hit with unexpected tax bills, so consult with a financial planner or tax pro before trying this at home.

How a mega backdoor Roth works

The mega backdoor Roth allows you to put up to $37,500 in a Roth IRA or Roth 401(k) in 2020, on top of the regular contribution limits for those accounts. If you have a Roth 401(k) at work (and the plan allows for the mega option as described below), generally you can choose whether the final destination of your mega contributions is the Roth 401(k) or a Roth IRA. If your employer offers only a traditional 401(k), then your mega contributions would end up in a Roth IRA.

Here’s a quick summary of what you need to have in place for the ideal mega backdoor Roth strategy:

A 401(k) plan that allows “after-tax contributions.” After-tax contributions are a separate bucket of money from your traditional and Roth 401(k) contributions. About 43% of 401(k) plans allow after-tax contributions, according to a 2017 survey of large and midsize employers by consulting firm Willis Towers Watson.

Your employer offers either in-service distributions to a Roth IRA — that is, you can take money out of the 401(k) plan while you’re still working at the company — or lets you move money from the after-tax portion of your plan into the Roth 401(k) part of the plan. If you’re not sure, ask your human resources department or plan administrator.

You’ve got money left over to save, even after maxing out your regular 401(k) and Roth IRA contributions. In 2020, that means being able to save more than $25,500 (that’s $19,500 to a 401(k) plus $6,000 to a Roth IRA), or more than $33,000 if you’re 50 or older ($26,000 to a 401(k) and $7,000 to a Roth).

» Can’t check those boxes? That’s OK. Run your numbers through our retirement calculator to see if you’re on track.

Here’s more detail on each of those bullet points:

Your 401(k) plan allows after-tax contributions

This is pretty straightforward: Either your employer plan allows after-tax contributions or it doesn’t.

If it does, here’s how to figure out the maximum amount you’re allowed to put into the after-tax portion of the plan:

The maximum that you and your employer combined can put into your 401(k) plan is $57,000, or $63,500 if you’re age 50 or older, in 2020. To calculate how much you can put into the plan’s after-tax portion this year, subtract your 401(k) contributions and your employer’s matching contributions from that maximum. (You’ll have to add up what you and your employer have contributed so far, and estimate what will be contributed for the rest of the year.) The remaining amount is the total you can put into the after-tax portion of your 401(k).

For example, say you’re under 50, earn $100,000, and you’re contributing $19,500 to your 401(k) plan this year. Let’s say your employer matches your contributions 100%, up to 3% of your salary. That means it’s putting in $3,000 this year. The maximum amount you can put in the after-tax portion of your plan this year is $57,000 minus $19,500 minus $3,000, which is $34,500.

If you don’t get an employer match, you’ll be able to stash the full $37,500 into the after-tax bucket. If you get a match, then that $37,500 will be reduced by the amount of the match.

Your 401(k) lets you move your after-tax money

If your plan doesn’t allow in-service withdrawals to a Roth IRA or in-plan rollovers to a Roth 401(k), then your opportunity to do the mega backdoor Roth is delayed until you leave your job. If that’s the case, you might want to reconsider this strategy.

The point is to get as much money into the Roth as soon as possible to get as much tax-free growth as soon as possible.

Joe Ghidossi, financial advisor with Moss Adams

Ideally, executing the mega backdoor Roth means throwing all of your after-tax savings into your after-tax bucket (once you’ve maxed out your $19,500 regular 401(k) contribution limit). Then, you’re almost immediately getting your money out of that bucket and into either a Roth IRA or Roth 401(k) before it starts accruing investment earnings. That’s because if left in the after-tax bucket, you’re going to eventually owe tax on those earnings. But once that money is in a Roth, your money grows tax-free.

“The point is to get as much money into the Roth as soon as possible to get as much tax-free growth as soon as possible,” says Joe Ghidossi, a financial advisor with wealth management firm Moss Adams.

If your after-tax contributions accumulate investment earnings, the IRS has said it’s OK to split up that money, by rolling your after-tax contributions into a Roth IRA and the investment earnings into a traditional IRA. That means your contributions will still grow tax-free, and your investment earnings will grow tax-deferred — you’ll pay income taxes when you take them out in retirement.

You’ve got money left over for savings

A mega backdoor Roth IRA is a sweet way to get a lot of money into a Roth IRA, but it’s really for folks who have a lot of money to put aside for savings. In general, it makes sense to first max out a regular or Roth 401(k) and a Roth IRA, if you’re eligible. Here’s why:

With a regular 401(k), you get an upfront tax break — your taxable income is reduced in the year you make your contributions, and you defer taxes on your investment earnings until you retire.

If you opt for the Roth 401(k), you contribute money that you’ve already paid taxes on. Your tax break is delayed, but your money grows tax-free and you get tax-free income in retirement.

If you’re below the income limits for a Roth IRA, it’s easier to simply contribute directly than to jump through all the hoops required for the mega backdoor Roth IRA. Here’s more on how to open a Roth IRA. If you’re above the Roth IRA income limits, then a backdoor Roth — the non-mega kind — is also an option.

If you’ve maxed out your 401(k) and a Roth IRA and you still have money to save this year, that’s when you’d consider a mega backdoor Roth.

Note: On rare occasions, a 401(k) plan may be forced to return your contribution to you. This generally happens only if you’re among the highest paid workers at your company. That’s because IRS nondiscrimination tests require that retirement plans don’t offer a substantially bigger benefit to high-income employees than rank-and-file workers. If the highest paid workers are saving at a much higher rate than other workers, the plan may be forced to return some of that money.

Can’t do a mega backdoor Roth? That’s OK

If you’re unable to do a mega backdoor Roth, don’t lose any sleep over it. Seriously, no need for FOMO here. The mega backdoor strategy is just one of a handful of ways to enjoy the beauty of the Roth treatment, where your money earns investment returns that you’ll never owe taxes on.

If you’re under the income limits, you can contribute directly to a Roth IRA.

If you’re over the income limits, you can get in with a backdoor Roth.

If your employer offers a Roth 401(k), you can contribute to that.

And don’t forget that if you’re saving and investing for retirement in any type of tax-advantaged account, you’re already ahead of the game. Kudos to you.

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